JOHN MASON: The New Era Of Volatility - Evidence From The Oil Market

As Friend of the Peak John Mason explains, a new era is upon us with increased uncertainty and greater volatility

Summary

What is happening in the Middle East and in Oil Markets is just another piece of the story and is really becoming more and more prominent in other major markets.

This development will have a significant impact on monetary policy decisions because the Federal Reserve and other central banks will not have the luxury of operating in calm markets.

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JOHN M. MASON

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AUTHOR: John M. Mason

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Uncertainty and volatility seem to have become the foundation of world markets these days.

Recently, I have written about the rise in volatility in the stock market and the bond market. But, this volatility has surfaced in many other markets, especially the commodities market, where it has raised some concerns about possible increases in the rate of inflation.

Sharon Nunn writes in the Wall Street Journal about the rise in the producer price index and about the increases in food prices and the turnaround in gas prices and the possibilities of these going higher in the near future.

For example, the two indexes published daily in the Wall Street Journal have both shown substantial increases since late June of last year. The S&P GSCI Futures Index has risen by 31 percent, from 353.80 on June 23, 2017, to close at 462.67 on Wednesday. The Thomson Reuters/Core Commodity CRB Index has risen by 18 percent over this period of time.

Leading this charge has been Crude Oil Futures that have jumped 48 percent over the same time period rising from $45.10 on June 23, 2017, to close at $66.78 on Wednesday.

Ms. Sider opens with "Oil surged to the highest levels in more than three years as tensions simmered in the Middle East, signaling optimism that a glut that has crippled the market for years is ending."

And this points to changes that have taken place within the world that are having major impacts everywhere, leading to greater uncertainty and volatility.

The world order is changing, and this is bringing in this new era.

Edward Luce argues, convincingly, in the Financial Times that some of this new order is due to the vacuum that the United States is creating by vacating the role in areas where it played a major role in the past.

Specifically, Mr. Luce in this opinion piece is focusing on the Middle East where the United States is becoming a marginal player in Syria - and elsewhere. "The region's players-even Israel-are looking elsewhere to fill the vacuum."

The possible impacts of this US move - the unintended consequences - threatens oil supplies and has had a major impact on the price of oil. One month ago, the price of crude was close to $60, while in early November, the price of crude was right around $54.

As the US position in the Middle East has become clearer, the price of oil has risen.

Ms. Sider writes,

"The International Energy Agency said last month that petroleum stockpiles in the industrialized world-a proxy for global inventories-stood just 53 barrels above the five-year average at the end of January, compared with a 302 million barrel overhand a year earlier."

Ms. Sider closes with this possibility:

"This summer, when drivers tend to hit the roads for vacation and fuel consumption peaks, gasoline prices are expected to rise to their highest level since 2014."

What if this does happen? What if prices begin to rise faster?

Well, when you start talking about rising prices, one starts to think about the Federal Reserve and other central banks.

The Federal Reserve has been arguing for several years that inflation would start to pick up again because it was felt that certain factors depressing prices - especially oil prices - would revert back to a higher level and this would result in the price index it most closely watched rising up to levels that were closer to the Fed's target rate of inflation.

Now, however, the Fed has to deal with the fact that the Trump administration oversaw the passage of the tax reform bill it wanted and then added to this the current budget that is very aggressively stimulative. Federal deficits are expected to soar.

The minutes from the March meeting of the Board of Governors of the Federal Reserve System was more optimistic about current economic data on price movements indicating that inflation was getting much closer to its target level.

Justin Lahart writes in the Wall Street Journal "Minutes from last month's policy meeting, released Wednesday, showed the central bank growing more confident inflation will reach its target…."

Mr. Lahart continues that,

"For the central bank, this would count as a happy event, since it would prevent too-low inflation from getting embedded in consumer expectations and make it less likely the economy will suffer deflation during a downturn."

Thus, the Fed can continue to raise its policy rate of interest and continue to reduce the size of its securities portfolio.

But, what if this doesn't happen in this way? What if price inflation accelerates to numbers above the Fed's target rate of inflation?

The economy is near full employment, and as Mr. Lahart reports, "The Congressional Budget Office on Monday said it expects the unemployment rate to fall to 3.5 percent by the end of the year." This bump comes from the tax reform bill and the new budget stimulus has not had time to really impact the economy.

Then oil prices could take off. And, there are many other places where major changes might take place. There is the possibility of a tariff war with China - and/or others. There is the situation in North Korea. And there are a lot of unknown, unknowns that exist out there because of the "vacuum" being created by the pullback of the United States in areas where it has been a major force in the near past.

Another area of uncertainty is the growing populism throughout the world, represented most recently by the election of Viktor Orban in Hungary, a victory that was celebrated by Geert Wilders of the Dutch Freedom Party and Marine LePen, of the French National Front, both populist leaders in their respective countries. And this does not include what is going on in Italy, and elsewhere in Europe.

What is the Fed to do in this world?

What are we as investors to do in this world?

The uncertainty and volatility we all now face represent a different era from the "no-drama" era we have apparently left.